Creston's results for the half-year to 30 September 2008, published this morning, confirm that trading profits have remained stable and contain no surprises. But there is one potentially weak spot, namely the extent to which its short term financial obligations (including earnout obligations) exceed its readily realisable assets like debtors and cash - what is termed its "net current liabilities".
At 30 September the net current liabilities amounted to £28 million and it could take some five years for cash generated from its trading activities to bring that deficiency down nearer to zero unless the group were to raise additional long term capital either from its banks or from the stock market.
There is no immediate cause for concern as the company is satisfied that its existing unused bank facilities will be sufficient to tide it over the near future when earnout obligations have to be satisfied.
The trigger for trouble would be a big slump in trading profit that could prompt a breach of one of the group's banking covenants and precipitate a demand for premature repayment. Certainly the coming months would not be an ideal time to reduce bank borrowings by raising new share capital, not just because potential investors are holding on to what little cash they have but also because Creston's share price has been languishing a long way below what its financial performance appears to merit (see "The Creston conundrum: why does its share price continue to slide?").
© Fintellect Ltd
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AIM-listed Digital Marketing Group ("DMG") - which has just announced a decline in half-year post-tax profit to £331,000 - recently bought a company from two of the founders of another company that the group acquired almost two years ago, thereby removing any potential risk of a conflict of interests.
The directors involved are Martin Boddy and Andrew Gardner. They founded database marketing agency Alphanumeric and have continued to manage it since DMG bought the company for an initial £14.5 million in January 2007.
DMG's more recent acquisition - voice marketing consultancy Gasbox - was set up by Boddy and Gardner in October 2006, only a few months before DMG bought Alphanumeric.
Gasbox traded at a loss up to 31 March this year, but rocketed into profit in the five month period to 31 August. In that most recent period DMG says the profit before interest, tax, depreciation and amortisation was £358,000.
DMG will pay up to £10 million for Gasbox in which Boddy and Gardner owned 50% of the shares. No explanation has been offered as to why Gasbox was not included in the original deal to acquire Alphanumeric when its value would have been far more modest. However, by delaying the purchase, DMG has avoided bearing the initial trading losses incurred by Gasbox.
DMG's half-year post-tax profit to 30 September was adversely affected by a fall in operating profit margin to 6.2% (after an increased charge of £1.6 million for the financial benefit of share options) and an abnormally high tax charge. The operating profit margin on revenue before charges for share options and amortisation of intangible assets was a healthy 18.9%.
Hasgrove, the AIM-listed digital and general marketing communications group, has raised almost £1 million of new share capital which it claims is to fund new acquisitions at potentially attractive prices and the further development of the existing business.
However, the amount raised seems very small and hardly worth the £50,000 incurred in raising it. Indeed it pales into insignificance when set alongside the group's existing shareholders' funds which amounted to £21 million last June and its net debt of £7.5 million, not to mention the £28 million invested in the intangible asset of goodwill arising from past acquisitions.
Of some relevance may be the shortage of working capital disclosed in the group's half year accounts to 30 June and the ongoing obligations to pay out deferred elements of company acquisition costs. At 30 June the group had short-term obligations that exceeded its short term assets by £4.7 million - up from £2.8 million last December.
Those obligations included £2.6 million relating to deferred purchase payments for companies Hasgrove has acquired which have to be settled within one year. Add that £2.6 million to the net borrowings of £7.5 million and the total would be getting intimately close to the company's bank facilities at 30 June of £10.5 million.
The cash situation may not be quite as tight as it first appears because some of the deferred purchase payment obligations may be settled by issuing more shares. Nevertheless, unless the group enjoys a sizeable influx of cash from operations or increases its bank facilities, there's not going to be a lot of spare cash swilling around waiting for further acquisitions or business development activities.
The continuing fall in the value of sterling against the dollar and the euro could provide a useful bonus when WPP Group reports its full year results for 2008.In the first nine months WPP's revenues grew by 14.9% over the corresponding period in 2007 - the biggest growth rate among the five major global groups - and half of that came from currency gains.
WPP's revenues for the third quarter were up 16.2% on those for the corresponding quarter in 2007. Without the contribution from exchange rate movements, that increase would have been a more modest 6%. And since 30 September sterling has lost another 20% of its value against the dollar.Currency movements had an adverse impact on revenues at Publicis Groupe and Havas, neither of which achieved any real material growth in the nine month period. Had it not been for that currency impact, Havas would have enjoyed a bigger revenue growth rate than WPP or any of the other major global groups.
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The price of shares in the publicly-listed marketing group Creston dropped again yesterday and have now lost almost 90% of their value since peaking in December 2006, begging the simple question: "Why?"
If the company is to be believed - and there are no obvious grounds for disbelief - there's nothing seriously wrong with its underlying trading performance, although its forward income projections are almost certainly being pruned back as the recession becomes a reality. Nevertheless the company reckons its income would have to fall quite a lot before banking covenants could come under pressure.
Creston is due to report its results for the half year to 30 September on 27 November and says this will confirm "the continuation of a solid underlying performance". If its half year profits after tax do no more than match those for the same period in 2007, they will be in the region of £2.3 million.
But its current share price would be more appropriate to a post-tax profit as low as £600,000, assuming an unexciting price/earnings ratio of 10 (or, expressed another way, assuming a return of 10% on the market capitalisation). No-one expects such a low profit and the company's pronouncements certainly suggest otherwise.
"New business activity continues to be positive", the company said on 13 October, at the same time as announcing the termination of discussions with a private equity group that was planning to acquire a controlling interest. The cost of those negotiations will hit half-year profits but the amount is not thought to be significant.
So nothing on the surface justifies the extent of Creston's share price plunge to date. A fall was inevitable in the face of a recession, but the scale of it would only be justified by a major event such as the loss of several major clients, a major write-down in the value of some of its acquisitions or a walkout by a group of key executives.
Oh well, Creston is in good company. Even WPP Group's shares are priced today at only 50% of what they would have fetched a year ago.
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On 24 September the chairman of AIM-listed marketing incentives group Motivcom said the company was "cautiously optimistic about forward prospects, with many areas of the group particularly suited to these current conditions", adding in relation to the gloomy economic outlook: "If history repeats itself, the forward prospects for our group are encouraging."
Today that same chairman Colin Lloyd announced a profit warning that sent its share price plunging by 39%. "As a result of the continued unprecedented conditions in the UK economy", Lloyd said, "the company anticipates that current market estimates on its headline operating profit for the year ending 31 December 2008 will not be met."
Few would be surprised that Motivcom's business could fall prey to an economic downturn. Nor would anyone attach blame to the company for being affected in this way. What is surprising is Motivcom's ability to prophesy a degree of immunity from these cold economic winds - a factor that presumably helped to minimise the fall in the company's share price last month when all those around it were plunging rapidly downwards - and then to shock investors by admitting that it too is subject to the harsh realities of the real world.
Media Square may be quietly pleased about the modest return to profit in the half year to 31 August announced today. Any profit must be better than the £25 million loss recorded for the full year to 28 February.
But a post-tax profit of £336,000 is meagre by any standards and shows just how far the group still has to go to win back investor support. Plans announced this week to put its main German operations into liquidation will draw a line under that drain on profits, but even without it the group achieved an operating profit margin of only 5.9% against an industry benchmark of nearer 15%.
The group had £44.5 million of capital employed in the business (shareholders' funds and net borrowings) during the half year, on which it earned a return before interest and tax of less than 4.5% (say 9% per annum).
But even that lowly return paints a misleadingly favourable picture because it ignores the fact that about £30 million of previously contributed capital had already been consumed by losses or amounts written off acquisition costs. Thus the total amount of capital invested in the business was nearer £75 million and the real return on that was nearer 5% pa. So the company may have done slightly better if it had invested all its assets in one of the more reputable banks. The argument against such a course (apart from it not being the purpose of the business) is the hope of a much better upside to reward investors for their patience and for the risk they have been taking.
Net borrowings remain very high at £17 million - virtually unchanged since February and costing £743,000 in finance charges for the half-year - but the company is making optimistic noises about being able to bring that burden down.
As Sir Martin Sorrell observed last week, WPP Group’s current budgeting exercise for next year may not reflect the Armageddon currently predicted by the fall in stock prices, but that’s not to say the picture will be a cheerful one either. Even Sir Martin acknowledged 2009 will be a “very tough year”.
So what can we read into the fact that, a week ago, WPP’s share price had dropped to half the value recorded six months ago (and was less than its previous low point in March 2003), but has since staged a modest 70p recovery?
The price recovery probably reflects a mixture of general market calming and relief that WPP’s predictions were not as bad as some had feared. Emotion is always a significant player in share pricing.
But none of this detracts from two underlying facts. First, WPP is about to spend over £1 billion in cash as part of the price it is paying for research group Taylor Nelson Sofres and for the existing borrowings it will assume as a result. The financing cost of that cash outlay will eat into next year’s profits while the group is busily rationalising the business it has acquired. No-one – not even WPP – expects an immediate payback on its investment.
The extra borrowing would not be excessive by normal standards – despite credit agency mutterings – but it could become more troublesome if the global economy is really heading downhill fast. Profits may prove hard to maintain. And margins are already under pressure.
Secondly, questions may be asked about the book value attributed to WPP’s previous acquisitions if the economy causes their performances to deteriorate. Write-downs of past acquisition costs (called “impairment provisions” by accountants) not only make a dent in the profits for the year under review but also diminish the amount of retained capital contributed by shareholders. If that happens, the key ratio of shareholders’ funds to borrowings will deteriorate too and that’s what tends to excite bankers.
Perhaps such a scenario will prove to have been nothing more than journalistic scaremongering. Let’s hope so. © Fintellect Ltd
BOB WILLOTT
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